Tax Rates on Capital Gains and Dividends Under the AMT

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Abstract

Recent tax acts sharply lowered tax rates on long-term capital gains and dividend income. For millions of taxpayers, however, the alternative minimum tax limits the benefits from these cuts by increasing the effective marginal tax rates on capital gains and dividend income. The culprit is the phaseout of the AMT exemption.

Introduction

Recent tax acts sharply lowered tax rates on long-term
capital gains and dividend income. For millions of taxpayers,
however, the alternative minimum tax limits the
benefits from these cuts by increasing the effective marginal
tax rates on capital gains and dividend income. The
culprit is the phaseout of the AMT exemption.
Just like the regular income tax, the AMT taxes capital
gains and dividend income at a maximum rate of 15
percent. The mere presence of that income, however,
increases the effective tax rate for affected taxpayers by
reducing the amount of income they can exclude from the
AMT.

The AMT exemption — $44,350 for single filers and
$66,250 for couples filing jointly in 2007 — phases out for
high-income taxpayers. For taxpayers with alternative
minimum taxable income above a certain threshold, the
AMT exemption decreases at a rate of 25 cents for each
additional dollar of AMTI. The 2007 AMT exemption for
single taxpayers, for example,
phases out over the AMTI
range from $112,500 to
$289,500. (For joint filers, the
range is $150,000 to $415,000.)
Within that range, the effective
marginal tax rate on capital
income equals the
statutory rate of 15 percent
plus the increase in alternative
tax attributable to the reduced
exemption amount.

The AMT applies two
statutory rates to all AMTI
above the exemption amount:
26 percent on the first
$175,000 and 28 percent on
any excess. A taxpayer with
AMTI above the start of the
AMT exemption phaseout,
but within the 26 percent
bracket, faces a 21.5 percent
effective tax rate on gains and
dividends — the 15 percent statutory rate plus an additional
6.5 percent effective tax rate due to the exemption
phaseout (the 26 percent AMT rate multiplied by the 25
percent phaseout rate). Similarly, a single taxpayer with
AMTI in the 28 percent bracket, but within the phaseout
range, faces an effective rate equal to 22 percent (15
percent statutory rate plus 7 percent, one-fourth of the 28
percent AMT rate).

The phaseout of the AMT exemption causes the effective
tax rate on capital gains under the AMT to climb as
income increases. The rate starts at 15 percent for those
with AMTI below the phaseout threshold, jumps to 21.5
percent and then 22 percent in the phaseout range, and
then reverts back to 15 percent once the AMT exemption
is fully phased out.

Because of the exemption phaseout, nearly half of all
AMT taxpayers — 46.5 percent — face 2007 marginal
rates of 21.5 or 22 percent on capital gains and dividend
income (see chart). Married taxpayers filing jointly are
more likely to face higher effective rates on gains and
dividends than single taxpayers and married taxpayers
filing separately—about half of joint filers have effective
marginal tax rates of 21.5 or 22 percent on capital gains,
compared to about 37 percent of other taxpayers.